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Report of the 16th Finance Commission for 2026-31

21 May 2026 Source

Exam Summary

The 16th Finance Commission (FC) report, chaired by Dr. Arvind Panagariya, was tabled in Parliament for the 2026-31 period. Key recommendations include maintaining states' share in the divisible pool of central taxes at 41%. The report details revised criteria for devolution, introducing 'Contribution to GDP' and adjusting weights for 'Income Distance', 'Population (2011)', 'Demographic Performance', 'Area', and 'Forest'. It recommends grants worth Rs 9.47 lakh crore for local bodies and disaster management, while discontinuing revenue deficit, sector-specific, and state-specific grants. The report also outlines a fiscal roadmap, suggesting a 3.5% fiscal deficit target for the Centre by 2030-31 and 3% for states, advocating against off-budget borrowings. Further recommendations cover power-sector reforms (DISCOM privatization), rationalization of subsidy expenditure, and public sector enterprise reforms.

GS Paper 2: Functions and responsibilities of the Union and the States, issues and challenges pertaining to the federal structure, devolution of powers and finances up to local levels and challenges therein. Constitutional bodies. GS Paper 3: Indian Economy and issues relating to planning, mobilization of resources, growth, development and employment. Government Budgeting. Fiscal policy and public finance.

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Exam Themes

Indian Economy Indian Polity & Governance Federal Structure & Centre State Relations Public Finance & Taxation

Prelims Takeaways

  • The Finance Commission is a Constitutional body constituted by the President every five years (Article 280).
  • The 16th Finance Commission's report is for the period 2026-31, chaired by Dr. Arvind Panagariya.
  • Recommended share of states in the divisible pool of central taxes is 41% (same as 15th FC).
  • New devolution criterion introduced 'Contribution to GDP'.
  • Key changes in weights for devolution criteria Income Distance (42.5%), Population 2011 (17.5%), Demographic Performance (10%), Area (10%), Forest (10%), Contribution to GDP (10%).
  • Grants-in-aid recommended total Rs 9.47 lakh crore, primarily for local bodies and disaster management.
  • Discontinued grants from 15th FC revenue deficit grants, sector-specific grants, and state-specific grants.
  • New grants for urban local bodies Special Infrastructure Grants and Urbanisation Premium Grants.
  • Entry-level criteria for local body grants constitution of local bodies, publication of accounts, timely constitution of State Finance Commission.
  • Disaster management grants cost-sharing 90:10 for north-eastern and Himalayan states, 75:25 for all other states.
  • Fiscal deficit targets Centre to 3.5% of GDP by 2030-31; states to 3% of GSDP annually.
  • Recommendation to strictly discontinue off-budget borrowings for states and include them in budgets.
  • Recommendations for power-sector reforms (privatisation of DISCOMs) and public sector enterprise reforms (review/closure of inactive SPSEs).

Elimination Traps

  • Confusing the specific devolution criteria weights or discontinued grants between the 15th and 16th Finance Commissions.
  • Misremembering the exact percentages for state's share (41%), fiscal deficit targets (3.5% for Centre, 3% for states), or disaster management cost-sharing ratios.
  • Incorrectly identifying the new or discontinued types of grants-in-aid.

Static Concepts

  • Finance Commission (Article 280)
  • Centre-State fiscal relations
  • Fiscal Federalism
  • Divisible pool of central taxes
  • Grants-in-aid (Article 275, 282)
  • Fiscal Deficit
  • Gross State Domestic Product (GSDP)
  • Off-budget borrowings
  • State Finance Commission (Article 243I, 243Y)
  • State Disaster Relief and Management Funds (SDRF, SDMF)

Probable Question Areas

Question areas
  • Role, functions, and constitutional provisions related to the Finance Commission.
Question areas
  • Key recommendations of the 16th Finance Commission regarding devolution of taxes, grants-in-aid, and fiscal consolidation.
Question areas
  • Comparison of devolution criteria and their weights between the 15th and 16th Finance Commissions.
Question areas
  • Impact of the 16th FC's recommendations on fiscal federalism and Centre-State financial relations.
Question areas
  • Specific details of local body grants, disaster management grants, and their conditionalities.
Question areas
  • Recommendations on fiscal roadmap, off-budget borrowings, and public sector reforms (DISCOMs, SPSEs).
Question areas
  • Significance of 'Contribution to GDP' as a new parameter for tax devolution.
Conceptual Recurrence

Related Prelims PYQs

Ranked by topic match, theme match, recency, and recurring UPSC patterns.

UPSC Prelims 2025 Economy

Which of the following statements with regard to recommendations of the 15th Finance Commission of India are correct?

I. It has recommended grants of ₹4,800 crores from the year 2022–23 to the year 2025–26 for incentivizing States to enhance educational outcomes.
II. 45% of the net proceeds of Union taxes are to be shared with States.
III. ₹45,000 crores are to be kept as performance-based incentive for all States for carrying out agricultural reforms.
IV. It reintroduced tax effort criteria to reward fiscal performance.

Select the correct answer using the code given below.

  1. A. I, II and III
  2. B. I, II and IV
  3. C. I, III and IV
  4. D. II, III and IV
Explanation
Correct answer
C. I, III and IV

The 15th Finance Commission made recommendations to promote better fiscal discipline, education, and agriculture reforms, while adjusting tax devolution among states. ✅ Statement I: Correct 4,800 crores were recommended (2022–23 to 2025–26) to incentivize states for improving educational outcomes. ❌ Statement II: Incorrect The Commission recommended 41% of Union taxes to be shared with states, not 45%. ✅ Statement III: Correct It proposed a ₹45,000 crore performance-based incentive for states to implement agricultural reforms. ✅ Statement IV: Correct It reintroduced the 'tax effort' criterion, rewarding states that better mobilize revenue in relation to their GSDP.

Indian Economy Indian Polity & Governance Public Finance & Taxation Federal Structure & Centre State Relations Constitutional & Statutory Bodies
UPSC Prelims 2023 Economy

Consider the following:
1. Demographic performance
2. Forest and ecology
3. Governance reforms
4. Stable government
5. Tax and fiscal efforts

For the horizontal tax devolution, the Fifteenth Finance Commission used how many of the above as criteria other than population area and income distance?

  1. A. Only two
  2. B. Only three
  3. C. Only four
  4. D. All five
Explanation
Correct answer
B. Only three

Based on principles of need, equity and performance, overall devolution formula is as given in the chart:

Indian Economy Indian Polity & Governance Public Finance & Taxation Constitutional & Statutory Bodies Federal Structure & Centre State Relations
UPSC Prelims 2014 Economy

The sales tax you pay while purchasing a toothpaste is a

  1. A. tax imposed by the Central Government.
  2. B. tax imposed by the Central Government but collected by the State Government
  3. C. tax imposed by the State Government but collected by the Central Government
  4. D. tax imposed and collected by the State Government
Explanation
Correct answer
D. tax imposed and collected by the State Government

The answer is (D) tax imposed and collected by the State Government is correct. In India, sales tax has been replaced by the Goods and Services Tax (GST). However, before the implementation of GST, sales tax was levied by individual states in India. While there might have been some central guidelines, the power to impose and collect sales tax primarily rested with the state governments.

Indian Economy Indian Polity & Governance Public Finance & Taxation Federal Structure & Centre State Relations
UPSC Prelims 2018 Economy

Consider the following statements

1. The Fiscal Responsibility and Budget Management (FRBM) Review Committee Report has recommended a debt to GDP ratio of 60% for the general (combined) government by 2023, comprising 40% for the Central Government and 20% for the State Governments.
2. The Central Government has domestic liabilities of 21% of GDP as compared to 49% of GDP of the State Governments.
3. As per the Constitution of India, it is mandatory for a State to take the Central Government’s consent for raising any loan if the former owes any outstanding liabilities to the latter.

Which of the statements given above is/are correct?

  1. A. 1 only
  2. B. 2 and 3 only
  3. C. 1 and 3 only
  4. D. 1, 2 and 3
Explanation
Correct answer
C. 1 and 3 only

Statement 1 is correct. The Fiscal Responsibility and Budget Management (FRBM) Review Committee Report indeed recommended a debt-to-GDP ratio of 60% for the general (combined) government by 2023, with 40% for the Central Government and 20% for the State Governments. This recommendation aimed to ensure fiscal discipline and sustainability. Statement 2 is not correct. The Central Government has domestic liabilities of 46.1% of GDP (2016-17) and as a percentage of GDP, States liabilities increased to 23.2 per cent at end-March 2016. Statement 3 is correct. The Constitution of India empowers State Governments to borrow only from domestic sources (Article 293(1)). Further, as long as a State has outstanding borrowings from the Central Government, it is required to obtain the Central Government's prior approval before incurring debt (Article 293 (3)).

Indian Economy Indian Polity & Governance Fiscal Policy & Public Debt Federal Structure & Centre State Relations
UPSC Prelims 2015 Indian Polity

With Reference to the Fourteenth Finance Commission, which of the following statements is/are correct?
1. It has increased the share of States in the central divisible pool from 32 per cent to 42 per cent
2. It has made recommendations concerning sector-specific grants

  1. A. 1 only
  2. B. 2 only
  3. C. Both 1 and 2
  4. D. Neither 1 nor 2
Explanation
Correct answer
A. 1 only

Statement 1 is Correct: The Fourteenth Finance Commission indeed increased the devolution of tax revenue from the central government to the states. Statement 2 is Incorrect: While promoting formula-based devolution, the commission does not provide recommendations regarding sector-specific grants to ensure focus on critical areas.

Indian Polity & Governance Constitutional & Statutory Bodies Federal Structure & Centre State Relations
UPSC Prelims 2021 Economy

With reference to ‘Urban Cooperative Banks’ in India, consider the following statements:
1. They are supervised and regulated by local boards set up by the State Governments.
2. They can issue equity shares and preference shares.
3. They were brought under the purview of the Banking Regulation Act, 1949 through an Amendment in 1966.

Which of the statements given above is/are correct?

  1. A. 1 only
  2. B. 2 and 3 only
  3. C. 1 and 3 only
  4. D. 1, 2 and 3
Explanation
Correct answer
B. 2 and 3 only

Statement 1 is incorrect. Urban Cooperative Banks (UCBs) are not solely regulated by State Governments. They are jointly regulated by the Reserve Bank of India (RBI) and the respective State Governments. In 2020, the Banking Regulation (Amendment) Act, 2020 gave RBI more control over UCBs, bringing them largely under its regulatory framework for financial stability. Statement 2 is correct. As per the Banking Regulation (Amendment) Act, 2020, Urban Cooperative Banks can raise funds by issuing equity shares, preference shares, and unsecured debentures with RBI approval. This allows UCBs to strengthen their capital base and improve financial health. Statement 3 is correct. Initially, cooperative banks were regulated under state laws. In 1966, an amendment to the Banking Regulation Act, 1949, brought Urban Cooperative Banks (UCBs) under RBI's purview for banking-related functions. However, their management and administrative aspects remained under state cooperative laws.

Indian Economy Indian Polity & Governance Reserve Bank Of India & Monetary Policy Constitutional & Statutory Bodies Federal Structure & Centre State Relations
UPSC Prelims 2021 Indian Polity

Which one of the following in Indian polity is an essential feature that indicates that it is federal in character?

  1. A. The independence of judiciary is safeguarded.
  2. B. The Union Legislature has elected representatives from constituent units.
  3. C. The Union Cabinet can have elected representatives from regional parties.
  4. D. The Fundamental Rights are enforceable by Courts of Law.
Explanation
Correct answer
A. The independence of judiciary is safeguarded.

Option A is correct. In a federal system, power is distributed between the central government and the states. There can be disputes about the division of power or interpretation of the Constitution.
An independent judiciary acts as an impartial umpire to settle these disputes and uphold the Constitution. It ensures that both the central government and the states function within their constitutional boundaries.The other options, while relevant to Indian polity, are not exclusive to federal systems Option B is incorrect. The Union Legislature having elected representatives from constituent units is a common feature in both federal and some unitary states with devolved power. Option C is incorrect. The Union Cabinet having elected representatives from regional parties is not a defining characteristic of federalism. Political party affiliation doesn't necessarily determine the federal structure. Option D is incorrect. The Fundamental Rights being enforceable by Courts of Law, while essential for a democracy, this feature exists even in some non-federal states.

Indian Polity & Governance Federal Structure & Centre State Relations Judiciary & Judicial Review
UPSC Prelims 2025 Indian Polity

Consider the following subjects under the Constitution of India:

I. List I–Union List, in the Seventh Schedule
II. Extent of the executive power of a State
III. Conditions of the Governor’s office

For a constitutional amendment with respect to which of the above, ratification by the Legislatures of not less than one-half of the States is required before presenting the bill to the President of India for assent?

  1. A. I and II only
  2. B. II and III only
  3. C. I and III only
  4. D. I, II and III
Explanation
Correct answer
A. I and II only

Statement I is Correct: Any change in the Union List alters the distribution of legislative powers and requires ratification by at least half of the State Legislatures. Statement II is Correct: Changes affecting the extent of a State’s executive power also need ratification by not less than one-half of the States. Statement III is Incorrect: Conditions of the Governor’s office can be amended by Parliament alone and do not require ratification by States.

Indian Polity & Governance Constitutional Amendments & Structure Federal Structure & Centre State Relations
UPSC Prelims 2019 Indian Polity

Which one of the following suggested that the Governor should be an eminent person from outside the State and should be a detached figure without intense political links or should not have taken part in politics in the recent past?

  1. A. First Administrative Reforms Commission 1966
  2. B. Rajamannar Committee 1969
  3. C. Sarkaria Commission 1983
  4. D. National Commission to Review the Working of the Constitution 2000
Explanation
Correct answer
C. Sarkaria Commission 1983

The Sarkaria Commission was established by the Government of India in 1983 to review Centre-State relations and recommend improvements. One of its key areas of focus was the appointment of Governors. Recommendations on the Appointment of Governor: - The Governor should be an eminent person with a distinguished record in public life. - The person must be from outside the State to ensure impartiality in administration. - The Governor should not have participated in active politics for some time prior to the appointment. - He should be a detached figure, not closely linked to local politics, to maintain neutrality. - The appointment process should involve wider consultation, including the Chief Minister of the State, the Vice President of India, and the Speaker of the Lok Sabha. These recommendations were aimed at ensuring that the Governor functions as an independent and neutral constitutional authority, rather than a political appointee of the ruling party at the Centre.

Indian Polity & Governance Federal Structure & Centre State Relations Executive & Council Of Ministers
UPSC Prelims 2025 Indian Polity

Consider the following statements:

I. The Constitution of India explicitly mentions that in certain spheres the Governor of a State acts in his/her own discretion.
II. The President of India can, of his/her own, reserve a bill passed by a State Legislature for his/her consideration without it being forwarded by the Governor of the State concerned.

Which of the statements given above is/are correct?

  1. A. I only
  2. B. II only
  3. C. Both I and II
  4. D. Neither I nor II
Explanation
Correct answer
A. I only

The Constitution outlines specific roles where the Governor can act at his/her own discretion, but it does not allow the President to unilaterally intervene in State legislation without the Governor's involvement. ✅ Statement I: Correct
* The Governor can act in discretion in certain cases (e.g., reserving a bill for the President under Article 200, or appointing a CM in a hung assembly).
* Article 163(2) makes the Governor’s discretion final in such matters. ❌ Statement II: Incorrect
* The President cannot suo motu reserve a State bill. Only the Governor can do this under Article 200.

Indian Polity & Governance Federal Structure & Centre State Relations Executive & Council Of Ministers State Legislature